10/13/2009 @ 3:15PM

Frothy Heights For Oil

The sharp weakening of the U.S. dollar, expectations of higher inflation and speculation has sent oil up this week to $74 a barrel, testing the highest levels in a year. But the tide is likely to ebb with demand iffy and Saudi Arabia expected to boost production.

“The oil price is definitely on the upper end of the trading range,” John Lonski, chief economist at Moody’s Investors Service, said Tuesday, adding that he doubts a price above $70 is warranted. “We just don’t see where the demand is.”

“You could get lucky, maybe have a very cold winter that would push the demand for heating oil,” Lonski said, “but it’s unlikely that the retail consumption of gasoline is about to rise dramatically, given the lackluster outlook for the unfolding economic recovery.”

The U.S. Energy Information Administration said in its latest short-term energy and winter fuels outlook that growth in China and other Asian countries has boosted expectations for higher oil demand. World oil demand fell 3.2 million barrels per day in the first half of 2009 compared with the same period in 2008. Preliminary EIA figures for the third quarter indicate consumption was 1.2 million bpd less than a year ago, but the fourth quarter is expected to rebound, breaking the downward trend of the past five quarters. The EIA expects the price of West Texas Intermediate to average $70 this winter, rising to $75 by December 2010.

The EIA has increased its forecast on world oil consumption a little, just 200,000 barrels per day for the rest of 2009 and 2010, but “ample oil supplies” and expectations of more production by the Organization of the Petroleum Exporting Countries will pressure prices. OPEC, which satisfies about 40% of global oil demand, has cut production over the last year, and won’t have an opportunity to make an adjustment until its next meeting, in December.

“The problem is I think it’s too late to keep from going close to $85 by the end of the year,” says George Littell, of Groppe, Long & Littell, an oil and natural gas analysis and forecasting firm in Houston.

Saudi Arabia has throttled down to 8 million barrels per day over the past year, but with the completion of the Khurais mega project and others in 2009, Saudi Aramco’s production capacity is expected to grow from 11.3 million bpd to 12.5 million. “There is a real hazard in here that once demand starts to recover, they will overestimate,” Littell says. “If they raise production too much, there will be a big collapse in prices and then they will have to cut it again.”

Littell expects oil prices will be around $60 again in 2010.

OPEC brightened its outlook slightly in a report released Tuesday, citing the gradual improvement in the world economy. It raised its forecast for 2009 world oil demand by 200,000 bpd to a contraction of 1.4 million bpd. It also raised its forecast for 2010 by 200,000 bpd to an increase in demand of 700,000 bpd.